How to Rebuild Credit after a Short Sale
By Eva Norlyk Smith Ph.D.
April 10, 2013
I had a short sale in 2010. Will be able to buy a house in 2014? I have had a bad credit history the past eight years. I have 20 years of credit history, and I don't have any revolving credit or hardly any credit open. I have settled my accounts with creditors. What's the best way to build my credit and maintain it? — Richard
Well, it sounds like there are a lot of factors affecting your credit. A short sale (selling your house for less than you owe on the mortgage) is an appealing alternative to a foreclosure, but unfortunately, your credit still takes a hit.
By most estimates, a short sale will cause your credit score to drop 100 to 160 points. Exactly how much will depend on what your credit rating was before the sale, how behind you were on mortgage payments and also on how the lender reports the short sale to the credit rating agencies. If the lender reports the sale with a deficiency balance (the amount you still owe even after the short sale), the effect on credit scores can be as much as a foreclosure.
Further compounding your situation is the fact that you've had a bad credit score for the past eight years, and that you don't currently have any credit cards or other types of credit open. In short, you have your work cut out for you!
On the bright side, while you may not qualify for a conventional mortgage loan so shortly after a short sale, you might have access to Fannie Mae or Federal Housing Administration (FHA) loans, which have more forgiving underwriting guidelines. For a Fannie Mae loan, if you can come up with a 20 percent down payment for a house, the mandatory waiting period for a loan after a short sale is only two years. To qualify for a loan with a down payment of only 10 percent, you'd have to wait four years. FHA guidelines are even better; after a three-year waiting period after a short sale, you could qualify for a loan with a down payment as low as 3.5 percent to 5 percent.
It will likely take you longer to rebuild your credit than the waiting period to qualify for a mortgage, however. But the good news is that you don't have to have top-rung credit to qualify for an FHA loan. For that, you'll need a credit score of 620 or higher and also be able to demonstrate that you've had steady employment within at least the past two years.
Still, even if your credit is high enough to scrape by for certain types of mortgages, it's still a good idea to try to build it up even more. You never know when you might need an auto loan or a personal loan in the future. Here are some steps to get you started
1. Find out where you stand: First, you need to find out what's on your credit reports and what your FICO score is. You can get a free copy of each of your credit reports once a year at AnnualCreditReport.com. Pull a copy of your reports from all three credit bureaus: Experian, TransUnion and Equifax. Then read over the reports carefully to make sure the information is correct — if you find errors, be sure to dispute them, as this alone can help improve your score. You can submit the dispute directly online at the websites of the credit rating agencies.
2. Get a secured credit card. There is no way around it: You have to use credit to build credit. If your credit's bad, you may not get approved for a regular credit card, so your best bet is to apply for a secured credit card. A secured card functions like a regular bank credit card in all respects, except you keep a (fully refundable) deposit with the card issuer to “secure” your credit line. So, in general, a $500 deposit will give you a $500 credit line, a $1,000 deposit a $1,000 credit line, and so on. Some cards will also give you a larger credit line for a smaller deposit. The Capital One Secured MasterCard, for example, allows you to obtain a credit line of $200 to $3,000 for a deposit of $49, $99 or $200, depending on your creditworthiness.
Many secured credit cards come with high fees, but a few are reasonably priced. For example, the Capital One Secured Card, which features a very manageable $29 annual fee.
3. Upgrade to a regular credit card. You won't have to keep the security deposit on your secured credit card that high forever. If you use the credit card regularly and pay the bills on time (and in full) each month, you should see improvement in your credit in as little as six months. Once your credit improves, try applying for a credit card for people with fair credit, and, a six months to a year after that, a second card. Then begin to phase out the secured credit card. Don't close that card or drop the credit line too fast, however; instead, wait for a credit history to build up on your other credit cards first.
4. Develop sound financial habits. The hardest part will be to do some soul searching and take a look at the financial decisions that caused you to have bad credit in the first place.
There are only two things you need to develop good credit: Pay all bills on time and pay all bills, including credit card bills, in full every month. If you introduce those two habits, everything else will follow in time. Technically speaking, it won't hurt your credit if you don't pay the credit card bill in full each month, as long as the balance stays under 30 percent of your credit limit. However, paying in full is the best insurance against accumulating credit card debt (which could easily get you back into the debt/bad credit cycle).
5. Create an emergency fund. Last but not least, begin to build up an emergency savings fund that you can draw on in the case of unexpected events. That will prevent you from charging more than you can afford on a credit card and derailing all your progress. So when unexpected events, such as medical expenses, car problems and emergency trips for family reasons arise you won't be left financially vulnerable.
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